The Dynamism of International Market Entry and Development: The Contribution of Path Dependency Theory
Andreas Klossek *
PhD candidate
Dept. of Economics and Business Administration
FreibergUniversity of Technology and Mining
D-09596 Freiberg, Germany
Tel: +49 (0) 3731 / 39-2119, Fax: +49 (0) 3731 / 39-3313
email:
Michael Nippa
Professor of Management, Leadership, and Human Resources
Dept. of Economics and Business Administration
FreibergUniversity of Technology and Mining
D-09596 Freiberg, Germany
Tel: +49 (0) 3731 / 39-2081, Fax: +49 (0) 3731 / 39-3313
email: /
* corresponding author
Acknowledgements:
We would like to thank Andreas Ehrhardt, R. Michael Holmes, Jr., Björn Rosenberger, and Daniel Tüx for providing valuable comments and suggestions on earlier drafts of this manuscript. An earlier version of this paper was presented to participants at the International Conference on Economics and Management of Networks in Budapest 2005 and at the 3rd Annual JIBS/AIB/CIBER/ERIM Invitational Conference on Emerging Research Frontiers in International Business in Rotterdam 2005.
The Dynamism of International Market Entry and Development: The Contribution of Path Dependency Theory
Abstract
Recognizing the scarcity of the application of path dependency theory in internatonal business (Buckley and Glaister, 2002; Eriksson, Majkgård and Sharma, 2000; Guisinger, Brewer and Young, 2003), this paper will address the deficiency by integrating a path-dependent view into well-known and widely applied organizational theories in international business research. Specifically, our research drew on resource- and capabilities-based, organizational learning and social exchange as well as network theoretic explanations of MNE international investment activity through international joint ventures. As a result, we have generated conceptual propositions and outlined possible directions for future research.
Keywords: Path Dependency Theory, International Joint Ventures, Foreign Direct Investment
The motives to form international joint ventures (IJVs) are manifold. For instance, they offer multinational enterprises (MNEs) the opportunity to draw upon knowledge and capabilites from local partners. Moreover, partners may be able to share costs and risk of entering new markets, offer infrastructure and knowledge for distributing products or providing specialized inputs, and so forth (e.g., Glaister and Buckley, 1996; Harrigan, 1986). From an MNE’s perspective, IJVs are often part of a portfolio of international arrangements. These range from hierarchical international investments like IJVs or wholly foreign-owned enterprises (WFOEs) to more hybrid, contractual arrangements such as strategic alliances, franchising, licensing, or exporting partnerships.
“Researchers have characterized joint ventures as transitional forms of organization (Davidson, 1982; Harrigan, 1986; Porter, 1990; Vernon, 1977).” (Yan and Gray, 1994, p. 1483) Hence, there are many indications that show that very often IJVs are terminated soon after they have been installed in a foreign country. There at least two reasons for why IJVs may be terminated by either one of the parents: firstly, the strategic focus of the foreign parent; and secondly, the poor performance of many IJVs.
Owing to an MNE’s strategic focus, IJVs in many cases are founded with the foreign partner’s objective to utilize this investment vehicle as a toehold entry into new markets (Harrigan, 1986) or, at least, as a transitional structure (Gomes-Casseres, 1987).[1] This has been especially the case in emerging markets like the People’s Republic of China (PRC), where unexperienced foreign firms aim for promising positions to enter the market (e.g., Xin and Pucik, 2003).[2] Hence, in 2004, nearly one third of all foreign direct investments (FDI) into China were IJVs (nearly $20 billion in 2004, according to Cheng, 2005), indicating strategic needs like overcoming the ‘liability of foreignness’ (Zaheer, 1995) or the need for better relations to governmental institutions when seeking resources or concessions (Pan and Chi, 1999). Nevertheless, there has been evidence that MNEs tend to favor WFOEs, either as their mode of initial entry or as an appendage of a prior entry mode (e.g., an IJV). Concerning the former alternative, Vanhonacker (1997, p. 131) anticipated “that half of all foreign investments in China will be WFOEs by the year 2000.” As he predicted, WFOEs now account for more than two thirds of all FDI in China (Cheng, 2005; Teng, 2004). Concerning the latter alternative, a recent study by Reuer (2000) found that most IJVs are terminated after an average of 6.7 years, 84% through acquisition by one of the parents. Amongst other, reasons for internalizing an IJV include MNE rent, profit seeking behavior, or an accelerated learning curve in a host country through an IJV.
The second reason why IJVs are frequently terminated relates to the poor performance that is reported very often for this particular mode of foreign investment (e.g., Beamish, 1993; Hambrick, Li, Xin and Tsui, 2001; Hill and Hellriegel, 1994; Kogut, 1988; Li, Xin, Tsui and Hambrick, 1999; Osland and Cavusgil, 1996; Vanhonacker, 1997; Zhu, Speece and So, 1998). In many cases, this is attributed to overall difficulties of partner selection (e.g., Luo, 1997; Makino and Beamish, 1998; Merchant and Schendel, 2000; Park and Ungson, 1997), to the management of inter-partner collaborative partnerships (e.g., Dussauge and Garrette, 1995; Holm, Eriksson and Johanson, 1996; Lin and Germain, 1998; Tse, Francis and Walls, 1994), or to the specific host country characteristics (e.g., Beamish, 1993; Killing, 1983; Sim and Ali, 1998).
In any case there are indicationssuggesting that the decision to internalize or terminate an IJV may be prevented or at least delayed by certain factors (e.g., Delios, Inkpen and Ross, 2004; Inkpen and Ross, 2001; Olk and Young, 1997; Serapio and Cascio, 1996; Yan, 1998). For instance, Delios et al. (2004, p. 457) found that “variables that contribute to persistence include high alliance termination costs, high sunk costs, and high alliance visibility.” As for joint venture termination, Olk and Young (1997, pp. 871-872) found that “[t]he more involved a member became in a poorly performing consortium, the more likely it was the member intended to stay.” Considering four case examples, Inkpen and Ross (2001) have shown that some strategic alliances indeed persist beyond their economically useful life. According to the study of Delios et al. (2004), MNEs persisted in 75 percent of the alliances although they had not made profit in the preceding five years of their existence. Taking into account each of these examples, it seems that lock-in effects occur at a certain point of time and restrain the option to leave or reorganize the initial investment mode. Thus, they cause firms to stay in the particular investment mode initially chosen. Therefore, certain investment paths (e.g., through an IJV) could result in path-dependent effects.
Furthermore, it has already been indicated by several authors that the choice of market entry mode in subsequent investments can be constrained by path-dependent effects that, for example, result from prior experience (Eriksson et al., 2000; Guillén, 2003):
The choice of entry mode in subsequent investments may be affected by experience with a particular entry mode. This notion, often referred to as path dependency, suggests that once a firm undertakes a sucessful acquisition, or greenfield entry, it may, all else being equal, prefer to continue with the same mode of entry. (Chang and Rosenzweig, 2001, p. 752)
Assuming that there are path-dependencies following the initial investment decision to form an IJV as the preferred market entry mode, the question arises which factors induce such dependencies. Therefore, in our study we will analyze selected factors and theories that may explain path-dependent tendencies, i.e., lock-in effects to IJVs as the initial organizational form. Yet, we will not explore impacts on subsequent investments into new lines of business. In order to reduce complexity, we will only focus on singular investment paths, i.e., the evolution of IJVs.
Despite recent calls for supplementary research (Buckley and Glaister, 2002; Eriksson et al., 2000; Guisinger et al., 2003), there are to our best knowledge no studies that explicitly and extensively introduced path dependency theory (as represented e.g. in Arthur, 1994a; North, 1990) to MNE singular investment modes so far. Moreover, no attempts have been made to relate path dependency theory to organizational theories that are relevant for international business research.[3]
Thus, it is our overall objective to integrate and incorporate the concept of path dependency into international business research. Specifically, we ask (1) where path-dependent effects might inhibit MNEs to switch from one investment mode (i.e., an IJV) to the next (i.e., a WFOE) or to terminate the specific investment mode (i.e., an IJV). Moreover, we seek (2) to advance possible applications of path dependency by providing factors and propositions that are driven by and based on prominent organization theories widely used in international business and IJV research.
To accomplish our objective, we will firstly elucidate existing research that attempts to explain the evolution or sequence of international market entry and development modes. Secondly, we will provide a brief overview of the theory of path dependence and will discuss it within the context of international business activity through an IJV. Thirdly, we will identify and will analyze organizational theories that might contribute significantly to the application of the path dependency concept to FDI decisions such as the resource- and capability-based view, organizational learning perspective, social exchange and network theory. In conclusion, we will propose future directions for this promising field of research.
Literature Review
Existing literature on IJVs is broad and varied and focuses on many different aspects of IJV management. Frequently, studies analyze the initial market entry mode decision (e.g., Anand and Delios, 1997; Brouthers, 2002; Mata and Portugal, 2000; Pan and Chi, 1999; Pan, Li and Tse, 1999), timing decisions (e.g., Isobe, Makino and Montgomery, 2000; Luo, 1998; Pan and Chi, 1999; Pan et al., 1999), or general success factors that determine the formation of IJVs (for an extended review see Reus and Ritchie, 2004; Robson, Leonidou and Katsikeas, 2002).
IJV research seemingly focuses on IJV formation-related, static issues, whereas dynamic, process-related issues are often ignored (Doz, Olk and Ring, 2000; Nippa and Klossek, 2004). In recent years, however, there has been a growing body of literature that widened IJV research focus by adding process-oriented, longitudinal issues (recently reviewed by de Rond and Bouchikhi, 2004) and a post-formation perspective of IJVs (e.g., Reuer, 2001). Additional insights that emphasize a process perspective of IJVs stem from literature on the internationalization process of the firm (e.g., Johanson and Vahlne, 1977). As we will prove in the following section, the concept of path dependency has received only minor attention so far. Although it has been implicitly or explicitly mentioned by some authors (e.g., Chang and Rosenzweig, 2001; Eriksson et al., 2000; Johanson and Vahlne, 1977), to our knowledge there has been no attempt to appropriately integrate the concept into international business research.
Internationalization Process Research
In order to outline the pattern of the internationalizing firm, internationalization process theorists (e.g., Johanson and Vahlne, 1977; Johanson and Wiedersheim-Paul, 1975; Luostarinen, 1980; Melin, 1992; Vahlne and Nordström, 1993; Welch and Luostarinen, 1988) systematically trace MNE expansion behavior in foreign markets. Not surprisingly, they find that internationalization processes differ significantly among MNEs. A recent review distinguishes between three individual schools of the internationalization process of the firm: “1) the economic school of Foreign Direct Investment (FDI) theory, 2) the behavioural school of Establishment Chain (Stage) models, and 3) the relationship school of the Network perspective.” (Coviello and McAuley, 1999, p. 225)[4]
In general, the economic school (e.g., Anderson and Gatignon, 1986; Buckley and Casson, 1993; Dunning, 1988) argues that the international expansion of firms is mainly driven by the assessment of costs (e.g., in terms of their extent, form, and location). Costs determine the optimal organizational form (i.e., the degree of internalization) and location of that activity (Coviello and McAuley, 1999). Despite of attempts to reveal the underlying managerial decision-making process beyond pure rational analyses (e.g., Aharoni, 1966; Newbould, Buckley and Thurlwell, 1978) the economic school takes up a rather static position.
The behavioral school pays more attention to the managerial decision-making process (e.g., Cyert and March, 1963; Luostarinen, 1980). According to Coviello and McAuley (1999, p. 226), “[t]he Establishment Chain (or Stage) models draw on organisational growth, behaviour and learning theory to capture internationalisation, and are generally argued to be more dynamic than FDI theory.” Those studies devoted to a stage model, primarily dating back to the Uppsala model (Johanson and Vahlne, 1977; Johanson and Wiedersheim-Paul, 1975), propose an incremental process of internationalization (i.e., from market-near arrangements to sales or production oriented investments).[5] This incremental process is mainly driven by the firm’s international market knowledge (i.e., objective and experiential) and commitment based on managerial learning (Johanson and Vahlne, 1990). Recent studies from Chang and Rosenzweig (2001) and Jiang and Beamish (2004) confirm that experiential learning from prior entries can explain managers’ choices of subsequent modes of market entries. For instance, Chang and Rosenzweig (2001) find that transaction cost- and culture-driven variables are mainly suitable to explain the choice of modes of initial entries but fall short to explain succeeding investments. Jiang and Beamish (2004) draw on timing (i.e., the earlier the initial investment, the more experiential knowledge gained and the more likely are reinestments) and resource commitment variables (i.e., the lower the initial resource commitment, the more likely are reinvestments) in hypothesizing that Japanese firms tend to pursue incremental entries rather than full-scale entries.[6] Whereas Jiang and Beamish (2004) do not mention the path dependency approach at all, Chang and Rosenzweig (2001) partly draw on it but fall short of explicitly applying it (e.g., through a description on the basis of events) to internationalization process issues. Nevertheless, the studies offer interesting insights based on their dynamic perspective of foreign market investment decisions.
Finally, according to Coviello and McAuley (1999), the relationship school extends the Uppsala model and views the internationalization process of firms as being additionally driven by the development and maintenance of relationships over time (Johanson and Vahlne, 1992; 2003), for example through drawing on theories of social exchange and resource dependency.
Apparently, some concepts implicitly use path dependendy-related explanations when elaborating on the relevance of the “history” of managerial experience, commitment, or network integration. In internationalization process literature, these factors are mainly applied to explain subsequent FDI decisions at the MNE level. In this respect, the literature on alliance processes and post-formation IJV dynamics may additionally offer appropriate and valuable further insights concerning IJVs as singular investment paths.
Alliance Process Research
A recent review by de Rond and Bouchikhi (2004) has studied the usage of process-related perspectives within strategic alliance research. The four generic types of process theories (i.e., life-cycle, teleological, evolutionary, and dialectical) apply stage models (e.g., D’Aunno and Zuckerman, 1987), frequently emphasize the economic relevance of inter-partner learning processes (e.g., Doz, 1996; Doz and Hamel, 1998), explain the change of alliances as a continuous cycle of variation, selection, and retention, or as dialectical interchange (Das and Teng, 2000). Yet none of the studies mentioned rely on the path dependency approach or related concepts for their explanations. However, the proposal of Ring and Van de Ven (1994) to focus on events[7] relates to the path dependency approach as path dependencies can be induced by a sequence of “small” events (i.e., events with big consequences).
Special Insights from Post-formation IJV Research
Although IJV research has been mainly concerned with the formation and negotiation phase of foreign investment modes (Doz et al., 2000), an important stream of research focuses on post-formation and exit-related issues of IJVs, highlighting either IJV instability versus stability or IJV internalization, termination, and survival issues.
IJV instability versus stability. IJV instability stimulated wide and varied research activities that mainly analyze factors such as interpartner conflict, cross-cultural differences, control/ownership structures, and so forth (for a review see Yan and Zeng, 1999).
Adopting the change-stability paradoxon discussed in organization theory (Poole and Van de Ven, 1989), Yan (1998) distinguishes between driving and restraining forces (i.e., structural inertia) for the structural reconfiguration of IJVs (whereas structural reconfiguration of IJVs will only happen if structural instability erodes the status quo).[8] It is proposed that political and legal constraints during the foundation period, the initial resource mix, the initial balance of bargaining power, and interpartner preventure relationship will impact IJV structural stability (ibid.). Almost similar findings have been proposed in a case study by Gray and Yan (1997). However, although implicitly inherent in the structural stability or inertia concept, path dependency theory, again, is not explicitly mentioned.
Delios et al. (2004) propose to apply escalation logic (e.g., Staw, 1976; Staw and Ross, 1987), a concept related to the instability or, more adequately, stability approach. According to Delios et al. (2004, p. 458), “escalation research has identified a variety of factors that lead individuals and organizations to persist with failing courses of action.” The authors analyze a number of international strategic alliances and identify three specific factors (i.e., large number of alliance partners, large size of alliance, possession of few other subsidiaries in host country) that foster persistence despite an obvious failure of the particular alliance. Albeit emphasizing mechanisms to overcome inertia, insights offered by Inkpen and Ross (2001) also indicate that especially project, psychological, social, and organizational and contextual determinants account for persistence in alliances.[9] Although the factors mentioned by both studies[10] are related to persistence, path dependency theory is not mentioned explicitly.
IJV internalization, termination, and survival. Notably, not every unstable or even unsuccessful IJV will be liquidated (e.g., Delios et al., 2004; Inkpen and Ross, 2001). Nevertheless, instability or escalation must be considered as heralds of failure and termination, whereas termination may not serve as the sole indicator for failure (e.g., Reuer, 2001; Reuer and Miller, 1997). It has to be treated as a proactive strategic exit option held by the MNE or the local partner and can lead to the internalization of a particular IJV (e.g., Reuer, 2000). As for the change of the governance structure that must follow such an internalization strategy, it has been found by Reuer, Zollo and Singh (2002) that specific features like the parent firm’s prior ties with local partners promote changes in the governance structure of the alliance (due to high partner familiarity and the emergence of inter-organizational routines). Contrarily, it has been found that network ties promote trust and familiarity and, thus, may avoid formal changes in alliances (Gulati, 1995) or even cause partners to remain within the actual alliance (Olk and Young, 1997).